At the ECB Forum yesterday, one of the topics was the impact of digitalization and central bank digital currency (CBDC) on monetary sovereignty. The currencies of the major economies will become even more dominant in this digital era. “That scares the heck out of smaller countries and emerging economies,” said Markus Brunnermeier, Princeton Professor and adviser to the BIS and Bundesbank.
“That’s why they’re at the forefront of introducing CBDCs in order to defend their currencies from the foreign currencies taking over,” he added.
He expects the US Dollar, the Euro and China’s Renminbi to become more dominant. For the United States, regulated stablecoins will make the dollar more prevalent in the digital space. “It is less likely that the US will be at the forefront of the CBDC development,” added Brunnermeier.
He presumes that Europe will be more inward-focused. For China, the major payment platforms AliPay and WeChat Pay will play a key role in the retail internationalization of the renminbi. While he noted that local regulators are clamping down on the two firms, we’d observe that this could be accelerating their global expansion, especially for AliPay and its parent Ant.
Brunnermeier talked about visits to Chinese restaurants in the United States where friends pay for meals in renminbi using the two Chinese chat apps.
“The concept of a currency area is shifting,” he said. “A digital currency area is not necessarily given by national boundaries.” This is a nod to earlier work in which the professor and colleagues spoke about currencies being relevant to platforms rather than countries. While the concept originally referred to platforms operated by AliPay, Ant and WeChat Pay, it’s often the case that specific cryptocurrencies are used on the associated blockchain networks.
Why monetary sovereignty matters
We’ve seen social media posts espousing the merits of various countries with weak currencies earning US dollar income through stablecoins. But a key part of monetary sovereignty is the ability to influence monetary policy. If a country’s own currency is dominant domestically, interest rates can be raised to slow down the economy or lowered to stimulate it. The more a foreign currency dominates an economy, the less influence the central bank has over the local economy.
Deviating from the talk for a minute, one could observe that Greece struggled to emerge from its financial crisis because it was part of the Eurozone and had fewer domestic economic tools at its disposal. However, Greece made a decision to join the Eurozone and also gained some benefits from it. With involuntary dollarization that often will not be the case. And dollarization here refers to the adoption of any non-domestic currency, not particularly the US dollar.
On a related note, the ECB Forum explored the ability for non-residents to hold a foreign CBDC and cross border payments
Non-resident CBDC holdings, cross border payments
Talking about non-resident CBDC access, Cecilia Skingsley, First Deputy Governor of Sweden’s Riksbank, outlined the options. “Should there be caps or fees? Should you be allowed to hold another country’s CBDC where you’re there as a tourist, or should you be able to hold unlimited amounts?” Each country will have to make a choice.
However, when it comes to CBDC for cross border payments, Skingsley managed expectations, saying CBDC is not a silver bullet for the challenges of cross border payments, although it can help with some of them.
She raised the issue of whether central banks will allow direct access to CBDC to foreign payment providers, the same point that was raised in the Project Dunbar paper for cross border payments. Most central banks currently limit access to central bank money to domestic institutions. Hence cross border payments often go through intermediary banks, which is a key part of the frictions in today’s international payments. If central banks don’t want to open up CBDC to foreign banks, some of these inefficiencies will persist.
Another key challenge will be interoperability. Skingsley observed that it would be ideal for all central banks to use a single system for cross border payments. But that will not happen because it’s too hard to agree on governance and supervision. Instead, rather than interoperability, there will be some interlinking, likely including a patchwork of different models.
She concluded that governance will make a difference more than technology. Countries need to agree on standards, regulations and supervisory committees. “Otherwise this will not work,” said Kingsley.
